Rajat Gupta: What Took Boards So Long To Oust Him?

Last Updated Mar 31, 2011 10:00 AM EDT

Rajat Gupta has a killer resume. He is on the short list of people equally distinguished in academia, business, NGOs, and mind-boggling net worth. His credentials added luster to many distinguished boards and commissions. And now, he is in a lot of trouble, and folks can't move fast enough to separate themselves from him. Do a Google search on "Gupta" and "resigns." It's quite a list.

Gupta was managing director of McKinsey & Company for almost a decade. He co-founded the Indian School of Business. He was the Chairman of the International Chamber of Commerce. And he served as director of Goldman Sachs, Harman International Industries, Procter & Gamble, and AMR. Now he is implicated in a messy insider trading case, and what was once a substantial reputational asset for all of those organizations has quickly turned into a serious reputational liability, and likely to be a legal liability, too.

The SEC claims that Gupta disclosed material non-public information that he received as a board member of Goldman Sachs and Procter & Gamble. If true, this is a shocking violation of the core confidentiality obligations of a director to the company and to the shareholders. It is also a violation of the duty directors owe to each other in order to establish the trust necessary for open, candid discussions.

Removal of a director is a sensitive and complicated issue. There are legitimate protections for board tenure, because we don't want directors to worry that bucking management might cost them their position. They can be removed for cause, but allegations of even serious impropriety are probably not sufficient. When a director gets in trouble, it is up to the other directors to ask for a resignation. And that is not something boards, who are always talking about the importance of collegiality, are very good at.

It is undeniably a tough call. People are innocent until proven guilty and boards have an understandable impulse to be loyal. But the boards here waited too long.

What Gupta did (allegedly)
The alleged recipient of Gupta's insider information was Galleon Group founder Raj Rajaratnam, who was first charged with insider trading in the fall of 2009. Gupta's name was not on the list of those involved when those charges were made public. Last week, Goldman CEO Lloyd Blankfein testified in the Rajaratnam trial that Gupta violated the firm's code of conduct by discussing confidential board deliberations with Rajaratnam.

Prosecutors have introduced a tape of a phone conversation showing Gupta revealing confidential matters to Rajaratnam. The tape is embarrassing, but may not be enough to prove that Gupta broke the law. Gupta has now sued the SEC in an effort to get his case moved from an administrative tribunal to a jury trial.

At what point between having charges filed against Rajaratnam and last week's revelations at his trial should Gupta's fellow board members at the companies not involved in these allegations have acted?

What boards should have done
For two reasons, the public announcement of the insider trading allegations at Galleon should have triggered immediate action from every organization, and especially every public company, with which Gupta had a current or recent past affiliation. First is Gupta's close connection to Rajaratnam (they were both members of New Silk Road Partners). Second is the centrality of the charges to Gupta's ability to perform as a director.

This means more than a simple conversation. I am familiar with one case where the board received anonymous but credible information that the CEO was bringing young female employees with him on business trips for sexual encounters. The board's response was to delegate one member to look into it. This consisted of one sheepish question about whether there was a problem. The CEO said no and the board did not pursue it further. The same anonymous source went public and it turned out there was indeed a problem and it was a big one.
  • The allegations against Galleon should have led to a serious, probing, conversation with counsel present and memoranda to the file. The questions have to be more than "is there a problem?" They have to be along the these lines: "Let's assume the government has access to your emails, your hard drive, and your telephone messages over the past two years. Is there anything that is likely to indicate that you might have disclosed confidential information, without regard to any intent or gain?"
  • They should also have led to a very candid conversation among the companies' other directors and top management to assess their own experience of Gupta's behavior and integrity. Did he gossip about his various activities? Was he sensitive to conflicts of interest of his own and of others? How did he respond to questions about ethics and values when discussed in the boardroom? Does he know the difference between the right to do something and something that it is right to do?
Every board should take this opportunity to have a frank discussion about how they evaluate board candidates. It may be that someone like Gupta is just too inter-connected to be able to really see the risks of passing along information and too busy to meet the duty of loyal commitment that board service requires. It may be that director integrity, discretion, and sensitivity to confidentiality rules are not emphasized enough in the board search, education, and evaluation processes.

And it may be that board members have not been encouraged to raise these concerns promptly. It is important to encourage confidentiality and candor in the boardroom, but that has to extend to the board's assessment not just of the company's direction and management but of itself as well.

Illustration copyright 2011 David Apatoff
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  • Nell Minow

    Nell Minow, a member of the board of GovernanceMetrics International and founder of The Corporate Library, writes about corporate governance issues, focusing especially on CEO pay, executive compensation, shareholder rights and best business practices.You can follow her on Twitter at @nminow.

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